Algeria, Still Avoiding Austerity

By: RICCARDO FABIANI.

February 28, 2017

 

The protracted decline in oil prices has been a major source of concern for the Algerian authorities for some time. For almost fifteen years, high oil and gas revenues have maintained the stability and prosperity that President Abdelaziz Bouteflika’s ascent to power brought. The drop in oil prices has widened budget deficits in recent years (the IMF recorded an estimated deficit of 16.2 percent of GDP in 2015, expected to widen to 17.9 percent in 2016) and depleted currency reserves, potentially triggering a balance of payments crisis if they run out by 2018 as expected.

However, with a delicate presidential succession looming in the background, the ruling factions are fearful of implementing tax raises or spending cuts that could cause social unrest and elite fracture. Fearful of triggering a wave of unrest, the authorities originally prioritized two approaches. The first was to use pedagogic discourse in the media to prepare the population for inevitable, yet unspecified, austerity measures. The second was to borrow domestically outside of the banking sector to tap savings generated by the informal economy. While the former is unlikely to have a considerable impact on a population that blames politicians for corruption and inefficiencies, the latter is key to understanding how the regime is trying to avoid any short-term fiscal adjustment.

In April 2016, the government launched a six-month domestic funding scheme by selling bonds to businessmen that have amassed enormous fortunes outside the formal economy. The thinking behind this initiative was that tapping this money would be sufficient to finance the government’s short-term spending plans while avoiding mopping up private savings in the financial sector. For this reason, the authorities issued both registered security and anonymous bearer bonds interest rates of between 5 and 5.75 percent. The option of anonymous bonds, which are securities for which no records of the owner or transaction are kept, provides a key guarantee to businessmen operating in the informal economy. However, this financing initiative failed to attract enough of their capital—and instead crowded out private investors and banks and exacerbated the liquidity shortage by diverting investments from the strained formal financial sector. After all, why would Algerian businessmen operating in the informal economy pour their savings into bonds that yield little more than 5 percent when there are more profitable transactions to make? For example, they could exploit the arbitrage opportunity by borrowing money at the official exchange rates and selling this foreign currency on the black market for profit.

Faced with this failure, the authorities sought a different approach. In November 2016, they broke the long-held taboo on external borrowing, securing a 900 million Euro loan from the African Development Bank. More significantly, Minister of Industry Abdeslam Bouchouareb has been spearheading a series of initiatives to boost investment and business activity in the non-hydrocarbon sectors. His strategy has essentially relied on two pillars: removing obstacles to investment and facilitating and protecting the development of a local manufacturing industry to replace imports. The government believes their foreign currency reserves buffer gives them a few years to see the results of this approach before they have to resort to austerity measures.

To achieve these goals, in July 2016 Bouchouareb started introducing more flexibility in the investment code, which used to put burdensome requirements on the private sector. The new code shortens the time it takes to obtain building permits, removes foreign companies’ obligation to borrow domestically and maintain a permanent foreign currency surplus, and limits the scope of the government’s right to bid first on the sale of foreign-owned businesses. While these measures fall short of making Algeria a business-friendly economy due to persisting obstacles in registering property, getting credit, conducting trade, and enforcing contracts, it still represents a major turning point in the authorities’ approach to economic policy.

The second pillar of this strategy has been more in tune with the country’s socialist past. Bouchouareb envisages a quick transition from a hydrocarbon-dependent to a manufacturing economy, but his strategy relies on state intervention through an import-substitution strategy to artificially create an industrial base. Foreign investment is welcome only as joint ventures with local companies—thus making sure that ownership remains firmly in Algerian hands. Only at a later stage should Algeria’s manufacturing sector start targeting export markets.

Indeed, in the past months the government has introduced quotas and other restrictions on importers, particularly in the automotive and cement sectors, while giving car dealers three years to invest in the car manufacturing industry if they want to keep their import licenses. Moreover, the Ministry of Industry announced a series of joint ventures between local and foreign investors in the automotive, cement, steel, and phosphate sectors. In addition, Bouchouareb aims to create a vast network of Algerian subcontractors, particularly in the automotive industry. The most high-profile example of this strategy has been the announcement of a joint venture between Volkswagen and Algerian car importer Sovac to build a factory that should produce over 100,000 cars per year for the domestic market by 2022. Once the local manufacturing industry can stand on its own and allow Algerians to replace certain imports, the authorities believe that exports will naturally follow. In a statement on January 5, Bouchouareb said that Algeria will start exporting cement and phosphates in 2017 and that by 2019 Algeria will become an emerging market.

This strategy marks the first comprehensive approach to the problem of economic development and industrialization in a country that for a long time has relied almost exclusively on recycling oil money into the economy. Nevertheless, it continues to ignore a series of issues that have undermined development in Algeria for decades. Beyond the emphasis on joint ventures and attracting foreign investment, there is no plan to support small- and medium-sized enterprises, which crony capitalists close to Algeria’s decisionmakers will continue to discriminate against. In addition, the uncertain political transition ahead means there is no guarantee that the regulatory framework will remain intact—and Algeria has seen many unpredictable changes in the past. Finally, the authorities have no plan to tackle the many long-standing problems that still hamper growth, such as low levels of human capital, poor economic governance, a lack of competition in almost all sectors, and an extremely challenging business climate.

 

Source: Carnegie Endowment for International Peace.

Link: http://carnegieendowment.org/sada/?fa=68121 

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